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The only way to make sense of the US market now is to consider valuation

07/09/2012

Nick Kirrage

Nick Kirrage

Fund Manager, Equity Value

The US may have been one of the world’s brighter investment spots during 2012 but, if we are honest, that is not saying a great deal. Looking to the future, however, what should investors now be making of the world’s largest economy?

Starting with the positives, some of the more encouraging pieces of macroeconomic data published  recently have related to the US housing market, which we last addressed in reverting to type. Some commentators have described it as looking “conspicuously cheap” versus history on a number of different metrics – particularly the important consideration of affordability.

Regular visitors to The Value Perspective will know how keen we are on mean reversion and so, with the US housing market looking so cheap, if it were even to move back up to average levels over the coming years, the housing and real estate sectors could make a significant contribution to the country’s GDP. That is not to say it will but it could – and that is quite a positive for the US economy.

Clearly, on the flipside, some poor macroeconomic numbers are emerging from the other side of the Atlantic. To pick out just three, we have seen the ISM – the measure of business sentiment that is the US equivalent of Europe’s purchasing managers’ indices – looking very weak, consumer confidence surveys collapsing and numerous corporate earnings downgrades.

In short, there are lots of things that should make investors very nervous indeed so how can we square that with the positives mentioned earlier? To our way of thinking, the only way you can prevent yourself running round in circles in this sort of situation is to consider valuation.

Unfortunately, that is probably the aspect that should make investors more nervous than anything else. On the whole, the valuation of the US market looks expensive – particularly in the context of cyclically-adjusted price/earnings (P/E) ratios such as the Graham and Dodd P/E.

Within the US market, there are of course some undervalued sectors – in articles such as Social not-working, we have, for example, talked about how cheap the valuations of many big blue-chip software companies are looking. But individual sector valuations are not the same as the valuation overall and, on average, the US stockmarket looks expensive relative to history.

Whenever you find yourself wondering how best to weigh up positive and negative macroeconomic factors, we would always suggest you consider what you are paying for an investment ahead of what you are getting – and what you are getting in the US at present looks relatively expensive. This is in stark contrast to Europe where pretty much every macro indicator looks diabolical – and yet the valuations there are now really very attractive in the context of history.

Author

Nick Kirrage

Nick Kirrage

Fund Manager, Equity Value

I joined Schroders in 2001, initially working as part of the Pan European research team providing insight and analysis on a broad range of sectors from Transport and Aerospace to Mining and Chemicals. In 2006, Kevin Murphy and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Kevin and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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